Social Security Going Broke – Solutions for When the Money Runs Out
More than one-half of Millennials believe there will be no money in the Social Security system by the time they are ready to retire, according to a 2014 Pew Research report. “I don’t think anyone honestly expects to collect a single penny they pay into social security. I think everyone acknowledges that it’s going to go bankrupt or kaput,” says Doug Coupland, author of “Generation X.”
What went wrong? Will Social Security go bankrupt?
In 1935, few of the program’s creators could have anticipated the condition of the Social Security program today.
The country was in the midst of the Great Depression with a quarter of its labor force – 15 million workers – idle, and those with jobs struggled to make ends meet as their hourly wages dropped more than 50% from 1929 to 1935. Families lost their homes, unable to pay the mortgage or rent. Older workers bore the brunt of the job losses, and few had the means to be self-supporting. One despairing Chicago resident in 1934 claimed, “A man over 40 might as well go out and shoot himself.”
Hundreds of banks failed, erasing years of savings of many Americans in a half-decade. People lived in shanty towns (“Hoovervilles”) or slept outside under “Hoover blankets” (discarded newspapers). Breadlines emerged in cities and towns to feed the hungry. Thousands of young American men hopped passing trains, sneaking into open boxcars in a desperate attempt to find work.
Democrat Franklin D. Roosevelt (FDR), promising a New Deal, defeated former President Herbert Hoover in 1932 with more than 57% of the popular vote and 472 of 531 Electoral College votes. Three years later, FDR signed a bill that would “give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.”
America’s legislation to provide social insurance to its citizens trailed most of the other industrialized nations, many by decades. Germany was the first to establish a program in 1889, followed by Denmark (1891), the UK (1908), and France (1910).
Despite the desperate conditions of the American public, some politicians railed against the new law:
According to author Robert S. McElvaine (“The Great Depression: America, 1929–1941“), Americans are brought up on the belief that meaningful work is the basis of life. Every person is required to make their own place – and strive to better it.
Those lucky enough to be employed during the Depression believed that “something is wrong with a man who can’t support his family.” Taxpayers called those in need of assistance “thieves and lazy, immoral people,” “human parasites,” and “pampered poverty pigs.” Citizens who needed help the most often preferred to starve or considered suicide, rather than bear the shame and ask for help.
Recognizing the social obstacles facing the relief program, the writers of the Act designed the program so that benefits were a “right earned” by workers by payments over years, not a “dole” delivered from the government. Their efforts were successful, according to historian W. Andrew Achenbaum. In a 50th Anniversary information paper prepared for a Ninety-Ninth Congress Senate Sub-Committee, he lauded the success of a Social Security program that plays a “central role in providing protection to American families they invariably face in a ‘modern’ society.”
Since the passage of the Act, the program has been amended numerous times to extend and expand protection to other groups of Americans. The amendments included:
Benefit payments were increased irregularly from 1950 to 1975. However, as concerns about the long-term solvency of the program emerged, Congress imposed more stringent eligibility requirements in 1980 and reduced benefits in 1977 and 1983.
Congress passed the 1935 Social Security Act with the intent that:
Roosevelt insisted that the program would be financed wholly by dedicated payroll taxes, rather than general government revenues. He worried that using general government funds for financing would give Congress a “blank check” that would be irresistible to politicians seeking election. As a consequence, the Act established a payroll tax to be paid by employers and employees at a rate of 1% each, up to a $3,000 maximum taxable income. By 2016, the tax rate had increased to 6.2% each, up to a maximum income of $118,000. These taxes support two different funds, the Old Age and Survivors Insurance Trust Fund (OASI) and the Disability Insurance Trust Fund (DI), of the Social Security program.
In the early years of the program, tax revenues exceeded benefit payments with the surpluses going to reserves. For example, collections of the tax in 1940 were $368 million with benefit expenditures of $62 million, resulting in a cumulative reserve of $2.03 billion. By 2016, annual collections and benefits had increased to $957.4 billion and $922.2 billion respectively, leaving a cumulative reserve of $2.8 trillion.
Additions to the reserve increased regularly from inception until 2007; since that year, the annual excess of revenues over payments has fallen from $190 billion to $35 billion. The 2016 Report of the Trustees of the Social Security Trust Fund project that program revenues (additions to the funds) will equal expenditures in 2019. The trust funds are projected to support benefits through 2034 before the fund balances are fully depleted.
In recent years, some politicians and economists have tried to bundle payroll taxes into a broad category of government taxes and characterize the benefits paid to beneficiaries as an unearned government entitlement. They conveniently overlook the intent of the Act’s sponsors to dedicate payroll taxes solely to the funding of the social insurance program. FDR, a few years after the Act, explained, “We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits.”
Veronique de Rugy reflects a standard attack from those opposed to the Social Security program with her claim that the “government’s trust funds [OASI and DI funds] aren’t like trust funds in the real world. Trust funds in the real world contain assets; the government’s trust funds basically contain IOUs. What that means in simple terms is that the government already has to go further into debt to pay Social Security’s bills – and it’s only going to get worse.” Presumably, in the down-is-up world of Washington, a U.S. Government IOU such as a Treasury Bill is not a “real asset.”
Congressman Xavier Becerra of California expressed the feelings of most Americans on this issue during a 2012 Hearing of the Sub-Committee on Social Security: “I do not understand the logic of those who say it [Social Security’s investment in Treasury bonds] is not real money. Americans paid real money into the system. It was secured by the most secure form of currency there is, which is a Treasury bond . . . In the 77 years Social Security has been around, you and I and everybody who works and has worked, we have contributed about $14 trillion into Social Security with our paychecks, our FICA contributions . . . we have used up about $13 trillion in paying out benefits. Hard cash left over, simple math, 14 minus 13, there is $1 trillion that Americans have contributed in cold hard cash to Social Security that has never been used . . . Because for decades that reserve has been gaining interest because it is held in Treasury bonds, it has added another $1.6 trillion [to the trust funds].”
The determination of what amount constitutes an adequate benefit has plagued lawmakers since the program’s origin, especially in regard to balancing the impact of the decision upon those paying the tax as well as recipients of the benefits.
One common measure of adequacy is the replacement ratio – the percentage of pre-retirement income that will be received at retirement. Reaching agreement on the proper ratio is difficult because its calculation is complex, subjective, and subject to the expectations about recipient demographics and the role of Social Security in the equation.
According to a 1987 Social Security report, only 1% of retirees (222,488) collected SS benefits in 1940 and one-fifth of those collected additional Supplemental Security Income to augment their small benefits, raising the total 1940 program cost to $35 million. The vast majority of older Americans continued to rely on part-time work, family assistance, and private charity for their living expenses.
The average mean monthly benefit for a retired worker was $21.97 or $263.64 annually that year. According to the 1940 Census, the average mean income for all Americans was $1,368, representing a replacement ratio of 19.3%. Social Security benefits represented the sole source of income for 11% of the recipients, according to the testimony of Social Security Board Chairman Arthur J. Altmeyer before the Senate Sub-Committee of Wartime Health & Education on January 28, 1944.
Since 1940, Social Security payments have become indispensable to Americans over age 65. According to the New York Times, the benefit represents 90% or more of income for 36% of recipients and more than one-half of income for two-thirds of beneficiaries. By 2015, the average monthly benefit had risen to $1,332.35 monthly ($15,988 annually) or slightly above the U.S. 2016 poverty level of $12,060.
In other words, one half of beneficiaries received more than $1,332 each month while one-half received less. The average median earnings for Americans was $28,851 in 2015, reflecting a replacement ratio of 55.4%. Over 64.2 million people received benefits for a total of $904.7 billion, according to the Social Security Administration.
Since the benefits were supported by the contributions of current and future beneficiaries, the program is designed to provide higher benefits to those who make the largest contributions. A monthly benefit – the Primary Insurance Amount (PIA) – is based upon:
Changes in the Social Security program have always been difficult to implement. Many citizens (53%) see “Big Government” as the source of the nation’s problem and would prefer smaller government and fewer services, according to a 2015 Pew Research poll.
At the same time, a majority of the public support increased Social Security benefits and higher taxes to support the program, according to the NASI poll. This apparent discrepancy creates a political minefield for politicians trying to resolve the funding/benefit deficit.
While few politicians (excluding Bernie Sanders) have advocated for a benefit increase in recent years, even fewer have proposed a decrease in benefits. Generally, Americans, including a majority of Democrat and Republican voters (71%), are adamantly against any benefit cut according to a 2016 Pew Research Poll.
It is not surprising that office-holders on both sides of the aisle recognize the danger to their political careers when dealing with the program.
Even those who equate any big government program to socialism favor the continuation of the Social Security program. According to a 2010 New York Times survey, Tea Party activists believe Social Security “is worth the costs . . . for taxpayers by a two to one margin.” Like most citizens, Tea Party conservatives “strongly believe that they have earned their Social Security benefits through years of hard work.”
Former Arkansas Governor and Republican presidential candidate Mike Huckabee complained in a 2015 CNBC interview that “Washington is like a strip club. You got people tossing dollars, and people doing the dance.” Former super lobbyist and convicted felon Jack Abramoff, writing in The Atlantic magazine, agreed.
Members of Congress say, “My vote is not for sale for a mere contribution. They are wrong. Their votes are very much for sale, only they don’t wish to admit it . . . Each time a lobbyist or special interest makes a political contribution to a public servant, a debt is created . . . Congressmen who take contributions from lobbyists and special interests are selling out nation to repay their debts of gratitude.”
For every special interest group like the American Association of Retired Persons (AARP) or Campaign for America’s Future that wishes to protect or expand the Social Security program, there is a group of equal influence trying to reduce benefits or eliminate payroll taxes (U.S. Chamber of Commerce, Business Roundtable, National Association of Manufacturers). These groups have significant political influence due to the number of voters they influence or the campaign funds they can deliver at election time.
Since a single vote on the future of Social Security may end a political career, office holders have been reluctant to take a firm, public position on the issue.
In 1940, the worker/beneficiary ratio was 159.4 to 1. By 1955, there were 8.6 covered workers per beneficiary. The ratio fell to 3.2 by 1980 and 2.8 in 2016. The downward trend is expected to continue for the next 20 years so that by 2035, only two workers will be paying into the program for every beneficiary. The ratio of workforce to beneficiaries has declined as Baby Boomers begin to collect benefits while growth of the workforce has dropped.
The Bureau of Labor Statistics projects that the annual growth in the labor force for the period 2000–2050 will be less than 40% of the growth rate experienced from 1950–1999 (0.6% versus 1.6%). The loss of jobs is attributed to increased offshoring of work and expanded technology to reduce the need for human workers.
According to analyses by the Economic Policy Institute, the vast majority of American workers’ wages grew at the same rate as increases in productivity from the end of WWII to 1973. Since that time, real wages have been stagnant or declined for 80% of U.S. workers even though productivity has increased.
The combination of fewer workers and insipid wages, paired with the increasing number of beneficiaries and automatic increases in benefits, exacerbates the funding crisis and limits politically acceptable solutions.
During the period 1964–2004, real growth in GDP exceeded 3% each year. The rate slowed to 1.6% in the decade 2004–2014, increased to 2.2% in 2015, and fell to 1.6% in 2016. The Congressional Budget Office economists project annual real GDP growth to average 2% through 2025. With the lower economic growth projections, Congress may be reluctant to raise payroll taxes sufficiently – if at all – to recoup the projected deficit in Social Security revenues.
In a previous effort to spur the economy following the Great Recession of 2008–2009, Congress actually reduced Social Security revenues. At President Obama’s urging, Congress passed a “Temporary” Payroll Tax holiday, effective for 2011 and 2012, reducing the employee’s portion of the tax from 6.2% to 4.2%. As a consequence, payroll taxes (Social Security revenues) declined sharply. The reduction was the first time that the link between payroll taxes and benefits had been severed since the program began.
According to Jason Fichtner, former Social Security Administration Deputy Commissioner, severing the link between the taxes dedicated to the program’s benefits meant that “beneficiaries could no longer claim they ‘earned’ their Social Security benefits. This [attitude] would erode future support for this vital program.”
Relying on the current tax revenues alone to support payments will necessitate a cut of 25% to 30% in benefits immediately following the depletion of the trust funds. Thereafter, benefits will gradually decline as the deficit between revenues and benefits continues to widen. The cuts will impact all beneficiaries, those currently receiving benefits as well as those who might receive them in the future.
Program trustees project a shortfall of approximately $11.6 trillion or 2.66% of payroll for the next 75 years. In other words, the payroll tax must immediately increase an additional 2.66% to support the projected payments.
Conversely, cuts in benefits equal to the shortfall can be used to cover the deficit. None of the choices are politically popular, leading some analysts to recommend a combination of increases and cuts to mitigate the deficit. For a full list of the proposed changes to Social Security, review the Summary of Provisions That Would Change the Social Security Program.
The continuance of the Social Security program is important to most Americans, whether identified as Republican, Democrat, or Independent. A 2014 poll by the National Academy of Social Insurance (NASI) indicated:
Republican and Democratic office holders have been unable to agree on the steps necessary to resolve the approaching funding crisis. The former has generally favored reduction in benefits while the latter proposes to raise revenues and limit benefits for those earning high income.
The following represent the more popular solutions to lower benefits for future beneficiaries.
In 1935 when the Social Security Act was passed, the Committee on Economic Security projected, “Men who reach 65 still have on the average 11 or 12 years of life before them; a woman, 15 years.” Today, a man of 65 can expect to live, on average, another 19.3 years; a woman 21.6 years. In 1983, Congress raised the FRA from 65 to 67, phasing in the increase depending on a person’s birth year.
While 75% of the NASI poll respondents are opposed to increasing the retirement age to 70, the change would significantly improve the prospects of the program’s longevity. The 2016 Social Security Trustees Report estimates that the savings resulting from increasing the NRA to age 70 by 2032, raising the early eligibility age to 64, and indexing future NRA levels to increase longevity would reduce benefits by the equivalent of 1.43% in payroll taxes, reducing the projected shortfall by 54%.
Changing the formula of the Cost-of-Living Adjustment to a new chained version of the CPI-W is projected to save the equivalent of 0.41%, about a 13% reduction in the shortfall. The new formula will account for people purchasing lower-cost alternatives in response to rising prices. Most people (76% of those polled by NASI) believe that current increases do not adequately reflect the rising costs faced by elderly Americans, so this adjustment is likely to have voting-booth consequences.
Several suggestions have been made to reduce future benefits, including:
Since two-thirds of Americans oppose cutting Social Security benefits, reformers have proposed a number of changes to increase revenues in order to offset the future projected deficits. Increasing taxes is especially favored by those currently at or near the age where they will begin receiving retirement benefits; those who will bear the burden of extra taxes are less enthusiastic.
Proponents have suggested a variety of raises in the current payroll tax rate of 12.4%, some of which would occur immediately and others that would be phased in over years. An immediate increase to 15.2% would eliminate the total projected deficit of 2.66% while a phased-in increase to 14.4% would reduce the deficit to 1.21% (a reduction of 55%).
Another recommendation is to immediately apply a 6% payroll tax on earnings above the current maximum taxable earnings of $127,200 (2017). This option would also eliminate benefit credit for earnings above the current-law maximum. Due to the fewer number of workers that would be affected, the revenues would cover about 1.19% of the 2.66% payroll tax deficit.
The proportion of the tax increase shared between employee and employer remains unclear and will be the subject of intense political negotiation before these changes are enacted.
There have been a variety of changes suggested for increasing the taxable wage base, including:
While reducing benefits is likely to be opposed by older workers, raising the payroll tax or increasing the level of wages subject to the tax would also have negative repercussions from younger workers. As a consequence, political office-holders have proposed other solutions to eliminate the projected gap.
President George W. Bush introduced a partial privatization program with his concept of Private Investment Accounts for Social Security during his 2005 State of the Union Address.
While favored by conservative groups including the Heritage Foundation and the Cato Institute, liberal organizations such as AARP and National Committee to Preserve Social Security & Medicare have repelled efforts to amend the present system. They believe that allowing private accounts is only the first step in Republican efforts to dismantle Social Security and drastically cut future benefits for workers.
If the Bush plan were enacted, Dean Baker, economist and co-founder of the Center for Economic and Policy Research, claims that “a fifteen-year-old today  who retires in 2055 will lose more than 35% ($160,000) of his currently scheduled benefit over the course of his retirement.”
Privatization – the transfer of public services to private industry – seems to be a politician’s preferred solution when forced to make an unpopular decision to either raise taxes or cut services. As a consequence, private contractors currently provide many of the services previously performed by government employees. Private industry employees currently fight the country’s wars, house prisoners, collect garbage, build infrastructure, and educate our children. Nevertheless, the effort to privatize Social Security remains controversial for reasons discussed in an earlier Money Crashers article.
Privatization would effectively transform Social Security from a Defined Benefit (DB) plan into a Defined Contribution(DC) plan, a transformation that most corporations have implemented to reduce their financial costs, most often due to less-than-projected investment returns. According to a study by the Pension Benefit Guaranty Corporation, the number of single-employer pension plans fell from 112,000 in 1985 to under 23,000 in 2014.
A DB plan provides a lifetime guaranteed benefit, and the employer guarantees the benefit; a DC plan allows limited employer contributions and the employee’s retirement benefit is unknown. The latter’s value is dependent upon the total employer contributions and the investment return on those contributions.
In other words, given the same amount of money contributed to a plan, a participant in a DB plan such as Social Security receives a predetermined monthly distribution for life while a Defined Contribution plan participant’s benefit is uncertain. According to a study by the National Institute of Retirement Security, “DB plans are good for employees: They offer the best chance for retirement security.”
Under the Bush plan, revenues for Social Security would be limited to the employment taxes collected while benefits would vary according to the return on each individual’s selected investment. Since the system would become a pure pay-as-you-go system, the deficit between revenues and benefits would disappear.
Several politicians (notably Republican Senators Ted Cruz and Rand Paul), bolstered by conservative and business groups, have proposed that a Value-Added Tax (VAT) replace the current payroll tax system as well as the corporate income tax. While a number European countries have utilized a VAT system for decades, it has been considered and rejected several times by Congress (including the Fair Tax Act of 2011).
Social Security actuaries project the impact of adding a VAT of 3.0% in 2018, increasing to 6.5% in 2019 while reducing the corporate income tax rate from 35% to 27% would actually increase the deficit by a minimal amount (0.02%). Opponents of replacing the payroll tax with a VAT complain that the action would sever the relationship between earnings and benefits that is the foundation of the Social Security program.
Critics of government or the Social Security program occasionally suggest that the deficits in the program could be resolved by eliminating inefficiency and fraud. President Trump has said, “I’m going to keep Social Security without change, except I’m going to get rid of the waste, fraud, and abuse.”
Mike Huckabee complained to his CNBC interviewer that “so many cheats are exploiting the Social Security.” For politicians seeking to avoid making hard decisions, claiming to stop fraud, abuse, and waste often satisfies constituents (49% of the public according to a 2013 Gallup Poll) who have little confidence that agencies and departments of the federal government can perform their responsibilities.
Unfortunately, the extent of fraud and waste in the Social Security program is exaggerated due to the large sums involved, according to the Committee for a Responsible Federal Budget, an independent, non-profit, bipartisan public policy organization. Their conclusion – eliminating all improper payments would reduce costs by less than the equivalent of 0.2% of payroll – is based upon analysis of various SSA Office of the Inspector General reports in recent years.
Robert J. Samuelson, in a 2008 Newsweek article, correctly predicted the problem facing the country today. “The closer the economy comes to stagnation, the more Americans will succumb to distributional struggles – not just between the rich and the poor, but also between the young and the old and between immigrants and natives . . . Start with government. It’s overcommitted in the sense that it’s made more promises than can be sensibly afforded. The largest of these involve retirement costs.”
Our biggest challenge is balancing the promises of the past with the needs of the future. Every American – Baby Boomer, Millennial, or Generation Z – will be affected today and hereafter by the decisions made to alter the Social Security program. Will we honor the promises to our aged at the expense of our posterity? Should we reduce Social Security benefits or raise taxes on our current and future workers? Any solution will be painful, but sharing the pain by reducing benefits while raising taxes seems both just and fair.
What do you think? Is social insurance a requirement in a modern society? Would you prefer to go it alone (without the protection of the Social Security program) and be willing to accept the consequences, good or bad, without complaint? Do you have another solution to the Social Security dilemma?
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike’s articles on personal investments, business management, and the economy are available on several online publications. He’s a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas – including The Storm.
Social Security Going Broke – Solutions for When the Money Runs Out
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